May 11, 2008

Italian doldrums

I am off to Milan this afternoon, first to talk to students at Bocconi university, and then to take part at a panel in a public conference on Governing Globalization. So I have been reading about recent economic performance in the EU, especially within the Eurozone, which will complete its first decade at the end of this year.

To me the EU is the most impressive achievement of international economic statecraft in the second half of the 20th century. But clearly not everything is hunky-dory, and Italy's performance of late has been particularly disappointing. I found the chart below, from one Bruegel's publications, particularly striking:

The chart reveals an important reason behind Italy's poor performance: a large real exchange rate appreciation. Compare this for example to Germany, where significant real depreciation (an increase in external competitiveness) has stimulated export growth and has been an important driver of recent growth.

What is surprising about this of course is that it wasn't supposed to be this way. These countries are all in the Eurozone, and they share a common currency. Nonetheless, inflation patterns have diverged. If the Eurozone was a country rather than a loose grouping of countries, workers would be migrating en masse from Italy to Germany. It's not clear that there are similar equilibrating mechanisms within the Eurozone.

(What about Ireland in the picture above, some of you may ask. Ireland has experienced both an appreciation and an export boom. Well, that is what is called an "equilibrium real appreciation": the real exchange rate movement is the result of export performance, not the other way around.)

Comments

One wonders however, given the continuing unemployment in the former East Germany and the availability of cheaper labour from former Iron Curtain countries: would employment migration from Italy to Germany really be that much of a realistic adjustment factor under current conditions?

Interesting graph. I wonder about your comment on the equilibrating mechanism though. Considering that free movement of labour is pretty much given within the Eurozone, I don't see how a single state would make a difference. Rather, I suspect that transaction costs such as learning a new language might be more problematic.

Dani, to which extent do you think this is connected to fiscal policies?

Among certain otherwise pro-EU pro-Euro circles in Norway the argument goes something like this:
"The Euro would be good, except that it removes the check on populist spending of oil money (which is higher interest rates). Hence, until we run out of oil, the Euro can not be desireable..."

In light of the above chart, to which extent do you find this argument valid? Can one find any support for the argument that reckless government spending still hurts the economy, but rather through decreased export performance?

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